Saturday, January 8, 2011

Is There New "Deal Talk" -- On A J&J Remicade®/Simponi® Settlement?

Apparently, at the Goldman conference during the week, Mr. Frazier off-handedly said there might be a Remicade®/Simponi® resolution "soon".

While all the post arbitration briefs ought to be filed by now, I suspect the oral argument portion hasn't yet occurred. So, the most likely explanation for Mr. Frazier's statement would be renewed settlement talks.

If so, as I've long contended, the settlement will almost certainly involve a significant reduction in Merck's share of the revenue and profit. J&J/Centocor has essentially no motivation to make offers. No matter how one slices it, the current agreement is enforceable, and nothing J&J could have done would amount to the sort of egregious level of bad faith that would even arguably allow Merck to claim an increased share of the profits. No, if there is a settlement, it will J&J doing the taking -- and New Merck doing the surrendering -- of profits.

Here is a first hand account of Mr. Frazier's remarks -- from a[nother] anonymous commenter:

. . . . Anonymous said. . .

Frazier also indicated that Remicade arbitration could be resolved soon. Seemed to imply a settlement could occur. . . .

January 7, 2011 11:33 PM. . . .

My guess is -- based on various earlier independent stock analysts' consensus projections, of the financial impact here -- that J&J wouldn't settle for anything less than a 50 percent reduction in Merck's take from the deal -- so, the net present value of such an arrangement would be around $5 billion of reduced sales through Merck. Given the high margins on these two products, I'd put the net earnings hit to New Merck at close to 60 percent of that figure, or say around $3 billion, most of it spread over just the next three years. With about 3.08 billion shares outstanding, that would make the EPS hit a little more than $0.97 (also spread over three years) -- or more than all of the expected GAAP 2010 Merck EPS. If it all fell in 2011, it would eclipse Merck's 2011 net earnings.

If all of that transpires in roughly the way I expect, Merck will be a stock with a handle in the high $20s, in my estimation (assuming a continuing less than 12 P/E multiple). So -- it may be that Frazier is going to take a 50 percent hit now, to avoid a 100 percent loss, later (like April of 2011).

To be fair here -- on a non-GAAP basis -- Merck projects more like $3.27 to $3.41 of NON-GAAP EPS for 2010. That makes the loss number seem less dire. However, recall that to "fill the hole", at Merck's 28 percent average gross margins (trailing twelve months), it will need 1/0.28 dollars of NEW sales -- or $3.57 of new sales, for each dollar of the missing earnings, just to "stay even".

If the missing earnings (from the settlement, in 2011 alone) are $1.15 billion to $1.55 billion (with another $1.5 billion in 2012, and beyond) then Merck will need new sales of between $4.11 billion, and $5.53 billion, in 2011 alone. And that will likely be on something like $42 billion of 2011 revenue. Where on Earth could Merck possibly scare up an incremental $5 billion in sales, or an additional 12.5 percent? I have no idea.

Remember, however -- a full-on win in arbitration, by J&J, would be even worse than this.

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